Sure, Have Your Cake, But…

Context: Both monetary and fiscal policies face serious dilemmas, and the current situation demands policymakers to decide on an appropriate trade-off between growth and inflation.

Dilemmas faced by the Fiscal Policy:

• Maintaining a high growth with huge expenditure: Real growth in 2021-22 will have to be 7.8% to make up for the contraction of the economy by 7.3% in 2020-21. Perhaps, a growth rate of at least 9.0% is desirable.
  • For growth to pick up, the first condition is to lift the lockdown(s) as early as possible.
  • Overall, government expenditures will have to be at least Rs.1.5 lakh crore more than the budgeted expenditures of Rs.34.8 lakh crore in 2021-22.
  • In this context, the fiscal deficit will have to go up, which may touch 7.8% of GDP; this will increase borrowings touching Rs 16.3 lakh crore as against Rs 7.1 lakh crore last year.

Dilemmas faced by monetary policy:

• Supporting government growth programme: Through following ways –
  • Direct funding of government expenditure: It is in this context some have talked about ‘printing notes’. However, This is a system that we abolished in the early 1990s. The Fiscal Responsibility and Budget Management (FRBM) Act also reiterates it.
  • Indirect monetisation of debt: The other alternative is for RBI to provide additional liquidity to banks and other institutions. Indirect is preferable because, in the direct method, the interest rate becomes a negotiated figure.
• Checking inflation: Increasing the liquidity in the system to support growth will raise inflation.
  • The CPI inflation rate at 6.2% in 2020-21 had exceeded the upper limit of the monetary policy tolerance range of 6%; in May, wholesale price inflation touched an unusually high level of 12.94%.
  • It is important not to treat what is happening to inflation as simply ‘cost-push. The policy action itself has an impact on inflation.

Conclusion:

• High government expenditure will require higher borrowing that, in turn, will require larger support from RBI, which will have its own effect on prices.
• Policymakers need to decide on the appropriate trade-off between growth and inflation.